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Proposed Construction - Cost Approach Problem

Discussion in 'Commercial/Industrial Appraisals' started by Michael S, Nov 30, 2011.

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  1. Michael S

    Michael S Senior Member

    7
    Mar 18, 2009
    Professional Status:
    Certified General Appraiser
    State:
    New Mexico
    I'm working on an appraisal of a proposed single-tenant retail building for a national credit tenant.

    I'm at the reconcilliation and the cost approach is about 10% below the income approach. The sales and income approach are within about 2-3% of each other and I feel pretty confident on both.

    The property is under contract for the purchase of the land for about $300,000. I've got several very good comps that place the value at closer to $200,000. The difference between the contract and market price for the land is pretty close to the difference between the cost and income approach. I'm trying to wrap my head around this and I feel like I've overlooked something. My supervisor is out of the office today so I haven't got a chance to discuss this with him yet.
     
  2. David Wimpelberg

    David Wimpelberg Moderator Staff Member Moderator

    29
    Mar 30, 2005
    Professional Status:
    Certified General Appraiser
    State:
    New York
    I am personally not a fan of using the Cost Approach for direct valuation of income-producing properties, though I believe it has it's use in determining feasibility.

    With regard to the site valuation, were all sales researched and verified? Various approvals, permits, planning work, and other issues related to a specific site can significantly affect the value. As a simple real-world example, there is a commercial property (underimproved; HBU as vacant and ready for redevelopment) that was purchased and resold for 22% more a few months later without any physical alteration to the property. The difference was that in the first transaction the property was sold "as is," and the second transaction included all necessary approvals for redevelopment.
     
  3. Michael S

    Michael S Senior Member

    7
    Mar 18, 2009
    Professional Status:
    Certified General Appraiser
    State:
    New Mexico
    All of the land sales had the same commercial zoning. It's a small town and the zoning code is pretty relaxed. The subject was a former gas station and the seller paid to remove all the tanks and improvements. The two best comps were all previously improved and the buyers had to pay to remove the improvements. The contract price made perfect since 7-8 months ago when it was signed based on the one decent sale, adjusted for an inferior interior location and the cost of demolition. However since the contract was signed two more similar sites have sold for about 2/3 the contract price.
     
  4. stefan olafson

    stefan olafson Senior Member

    0
    Apr 2, 2003
    Professional Status:
    Certified General Appraiser
    State:
    North Dakota
    I'd make sure, through verification with more than one party to each sale, what truly took place on each sale. If the contract made sense 7-8 months ago, maybe what you are seeing is a continued downward spiral of values because of the slump/recession in the national economy.

    If income and sales comparison approaches are similar I'd hang my hat on those and maybe exclude the cost approach.
     
  5. Michael S

    Michael S Senior Member

    7
    Mar 18, 2009
    Professional Status:
    Certified General Appraiser
    State:
    New Mexico
    The land value made sense when they signed the contract. There was a sale about 10 blocks away of a similar size interior site for about $9.50 a square foot. Add in the $30,000 in demolition costs and an adjustment for the subject superior corner location and it's right at the contract price of about $11.50/SF. However since then there were two sales that after demolition costs are both about $7.00-7.50. The two more recent sales didn't really require any adjustments, one is a block away the other about 8 blocks away.

    I'm hanging my hat on the income approach since some of the sales required a fair amount of adjustments. However since this is proposed construction I feel like I need to explain why this gap exists. After all why would you pay more for new construction than what it costs to build? It seems like the difference has to do with the developer securing the long term contract and actually going through the development process. However it seems like that's already been accounted for in the indirect costs and entrepreneurial profit. I spoke with one developer who said he usually looks for about 20% or more, but the developer of this property seems willing to do it for 10% or less.
     
  6. sail143

    sail143 Junior Member

    2
    Oct 6, 2011
    Professional Status:
    Certified General Appraiser
    State:
    Rhode Island
    With proposed construction the cost approach must be considered. You likley have a declining market since the signing of your contract. Like they say check it all out.
     
  7. skx172

    skx172 New Member

    0
    Mar 5, 2008
    Professional Status:
    Appraiser Trainee
    State:
    New York
    My input:

    A site with a forward commitment by a credit tenant is worth more than a site without such a tenant.

    its worth more because, a) you dont have leasup costs b) a credit tenancy implies a higher value upon completion that a speculative tenancy

    did these guys secure a tenant before they signed the contract? did the contract have a hard deposit or was there a period during which they could have walked away.

    its possible you need to adjust your land sales up because they did not have a commitment from a credit tenant like you did. the higher land value will tighten up your cost approach to the other two approaches.
     
  8. Michael S

    Michael S Senior Member

    7
    Mar 18, 2009
    Professional Status:
    Certified General Appraiser
    State:
    New Mexico
    The land purchase contract was executed a month or two before the lease. The buyer is a national merchant builder/developer and the contract stated they had 45 days to get approval from their national retail tenant. If the tenant didn't give their approval the buyer could walk away. They put down some earnest money but just a few thousand.

    I'm not sure if I agree with adjusting the land value because of the commitment from a national tenant. It's one thing if there's approval in place for development but this feels like something totally different.
     
  9. Pittsburgh Pete

    Pittsburgh Pete Elite Member

    25
    May 6, 2008
    Professional Status:
    Certified General Appraiser
    State:
    Pennsylvania
    You might, however, adjust your level of entrepreneurial profit. If you went with the developer's 10% you might be underestimating the market, especially for a building with a quality national retail tenant. Perhaps the 20% quoted by your other developer might be more realistic and reflect the market better.
     
  10. CANative

    CANative Elite Member

    62
    Jun 18, 2003
    Professional Status:
    Certified Residential Appraiser
    State:
    California
    I was going to suggest that his developer buddy has more tolerance to risk. But then I started thinking the problem could be anywhere in the process (cap rate error, market noise, adjustments, etc., etc.)
     
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